The Game has Changed
We don’t often have “regime” changes, but when they happen, it’s meaningful and long lasting. So yes, I will go ahead and say it, this time is different. And what’s changed is actually structural in how markets work and investment decisions are made. This has vast implications for future investing decisions. And just as an aside, there are a couple of other changes related to this one which are also contributing to a New Market Order.
What’s changed is the dramatic increase in “passive investing”. As you can see below, since 2012, the Passive % of All Equity Funds has increased from 33% to 58% in just 12 years.
Why does that matter?
It matters because investing “passively” means there is no analysis or thought going into what you are buying. You give the fund manager money, and they buy everything in the index and the price of a holding is irrelevant. An “active” fund manager, conversely, would actually do some type of analysis (economic, fundamental, technical, etc.) and try to allocate the contributions in the most advantageous way possible.
Now when the % of Passive funds was low, that difference didn’t really matter. Now it apparently does. We seem to have crossed the threshold where Passive decisions (along with a few other things) are driving the bus when it comes to market moves.
The effects of this change have thus far been very positive. By default, if price doesn’t matter, as long as money is flowing in, all is sunshine and rainbows. The problem comes when money is flowing out. Again, price doesn’t matter. So the same indiscriminate buying, then becomes indiscriminate selling.
Mike Green makes a point that distributions are based on asset levels while contributions are based on incomes.
Think about that for a second –
A quick example, if asset markets are inflated due to structural passive investing, a 4% RMD distribution might be a relative large $ amount. In order to offset that distribution (more than offset to get net inflows), you need an equivalent $ amount from, say, 401k contributions linked to employee incomes.
Ok…
So that’s fine as long as the working group (incomes) is bigger than the retired group (RMDs). But what happens if the retired group is much bigger? You get net OUT-flows, and if markets are 60%+ passive, that could be a real problem.
The economy still matters because certainly contributions going into passive investment funds is tied to retirement savings into 401ks. So again, employment is a lynchpin.
But flows out due to retirement needs, medical expenses, RMDs, travel, … from the Boomers is going to be very important to monitor, because the mechanics around freeing up those funds has dramatically changed.
